Islamic Law Related to Commercial Transactions in Light of Contemporary Financial System

Written By Dinda Revolusi on Selasa, 22 Februari 2011 | 16.05

A large literature has discussed the role of law and legal institutions on financial development. One of the important determinants of financial development is adaptability of law to changing conditions. Adaptability underscores the formalism of laws and the ability of legal traditions to evolve. Specifically, legal systems that adapt efficiently to the contracting needs of the economy foster development of the financial system.

Empirical studies have compared the adaptability features of the civil and common law countries and found that more flexible legal systems can explain the status and development of the financial system. While most studies on the effect of legal system on financial development are related to variants of the civil and common law regimes, there is no attempt to discuss the status of Islamic law on finance. This research will fill this void. The paper first aims to examine the main features of Islamic law and identify its adaptability characteristics, and then discusses the scope of developing a sound legal infrastructure related to financial sector development.

A legal system comprises the legal order and legal regime (Kornhauser 2001). While the order consists of the legal norms of the system as expressed in the constitution, statutes, administrative regulations, juridical decisions, etc., the legal regime represents the existing legal institutions like legislatures, administrative agencies, courts, etc. Elements that support the proper functioning of the legal system can be termed as infrastructure institutions. These include appropriate laws enacted by legislature, courts for implementing the laws, etc. The financial structure of a modern economy is composed of the financial markets and intermediaries (Santomero and Babbel 2001). Financial development, therefore, signifies efficient functioning of the markets and intermediaries in providing the financial needs of the economy.

The question of adaptability of the law to changing circumstances is vital to the development of Islamic financial system. Issues like legal formalism, dynamism, and the efficiency with which laws can adapt to changing circumstances will determine to a large extent how this sector will grow in the future. The scope of this paper is, however, narrow. This study does not deal with the whole body of law or the legal system. While the main focus of the paper is the adaptability of law, some aspects of the legal infrastructure related to the financial sector development are also discussed.

While Islamic law encompasses various subject matters like rituals, family, inheritance, criminal, constitutional, fiscal, etc. the focus of this paper is on injunctions on commercial transaction (Islamic commercial law) only, as it is this law that is relevant to financial growth. The paper is organized as follows. Section 2 discusses the nature and adaptability features of the civil and common law traditions. While Section 3 outlines the sources and evolution of Islamic law, Section 4 analyzes its adaptability features. In Section 5, some recommendations related to the legal infrastructure institutions that may facilitate growth of the Islamic financial sector are provided. The last section concludes the paper.